The Eurozone debt crisis has led to increasing imbalances among Europe’s central banks, the causes and consequences of which are the subject of fierce debate. But this column argues that the discussions are missing a fundamental point – the extent to which the German financial sector and German savers benefit from this arrangement.

The European debt crisis has led to increasing imbalances between Eurozone central banks, which then show up in the TARGET system (also known as the TARGET2 system). The causes and consequences of this phenomenon are the subject of a vivid and controversial debate (Sinn and Wollmerhäuser 2011, Buiter et al 2011, Merler and Pisani-Ferry 2012).

However, one point so far has been neglected in the debate – the extent to which the German financial sector and German savers benefit from the TARGET imbalances. As we will argue, a significant share of the changes in the TARGET balances is effectively a transfer of risk from the balance sheets of the private sector in Germany to the Bundesbank and, hence, the public sector’s balance sheet.

Within the Eurozone, financial flows between national central banks of the Eurosystem are operated via TARGET, an online real-time cross-border settlement system. While the transactions are complex in detail, the economic logic behind them is very simple. If a country has a net TARGET liability, its banks in total have experienced net outflows of funds to the rest of the Eurozone. Conversely, if a country has net TARGET claims, its banks have received a net inflow of funds (Bundesbank 2012).

The TARGET liabilities of most peripheral European countries have increased dramatically since 2009, while Germany's TARGET claims jumped to a staggering €547 billion in February 2012. The main reason for this is that as private investors and savers withdrew their money, peripheral banks had to access their respective central banks in order to meet their refinancing needs. Banks in the core, however, attracted more than enough liquidity on the interbank funding markets. As private capital flows to the south were drying up, they have been replaced by official capital flows in order to prevent a sudden stop.

This mechanism is demonstrated in Table 1, where the changes to the different positions in the balance sheet are shown if funds are repatriated to the centre. In this case, the imaginary commercial bank “Centre Commercial” has not rolled over a loan to the also imaginary “Periphery Commercial” with the volume C. As a consequence, Periphery Commercial has increased its borrowing from the periphery central bank by C and has used the money to repay the loan to Centre Commercial. Centre Commercial, in contrast, has parked the money in its account at its central bank. As the payment has been booked through the TARGET system, the periphery central bank’s TARGET liabilities have increased by C while the centre central bank’s TARGET claims have increased by C. Note that if we were to consolidate the balance sheets of the two central banks’, net claims would not change.

Table 1. Centre Commercial and Periphery Commercial accounts

In the national account of the centre, these transactions would show up as a capital inflow (the repatriation of the loan) and a similar outflow (the increase in the TARGET claims). In fact, Germany's TARGET claims amount for an ever-increasing share of the country's capital-account deficit (Bornhorst et al 2012). This corresponds with an increasing share of TARGET claims in Germany's foreign claims. In the fourth quarter of 2011, the net foreign investment position stood at €933 billion, of which €483 billion was TARGET claims. This is the economic equivalent of a swap of claims against private banks in the periphery against a claim again the central bank in the periphery.

A number of commentators, led by Hans-Werner Sinn in Germany, have argued that this is a form of expropriation of German savers, who are witnessing a transformation of the country's external wealth. “The marketable assets of savings banks, banks and life insurance companies, which back the savings (…) were exchanged without consent of the savers into claims against the ECB” (Ifo-Institut 2012). These claims are seen as inferior to private claims as they disappear if the system collapses.

Yet on closer inspection, this argument seems to get the logic completely wrong. It implicitly assumes that private sector entities in the periphery would honour their euro debt in full if the Eurozone disintegrates, while claims against the central bank in the Eurozone periphery would need to be written down. From all the experience we have from emerging market crisis, this is clearly nonsense. An exit of a periphery country from the Eurozone and a following depreciation of the country in question would increase strongly the value of all euro liabilities in households’ and firms’ balance sheets. Given that these entities would earn their revenue in (newly issued) domestic currency, this currency mismatch would render many of them bankrupt overnight. There are only two solutions to this problem – mass defaults of households, firms, and banks in the exiting country or a redenomination of the liabilities in the new domestic currency. In both cases, creditors from the north would lose (parts of) their wealth.

In addition, while it is true that marketable direct claims on the aggregate level have been replaced by non-marketable indirect claims through the Eurosystem, these claims can sensibly be assumed to be safer than the original assets.

First, Germany now has a matching claim against a periphery central bank, which in turn has a claim against a commercial bank in its territory. There is no reason why such a claim should be less secure than a direct claim on the commercial bank in the periphery.

Second, if the euro does not disintegrate altogether but only single countries leave, the potential losses for Germany have become smaller, not larger. According to the ECB's statutes, losses in the Eurosystem are distributed among the central banks according to their share in the ECB. The Bundesbank's capital share is 27%, which means that Germany would only have to take less than one-third of the total losses, compared to the full amount that private creditors would have to take. The rest would be borne by those partner countries that remain in the euro with Germany.

Third, the shifting of the risk of a collapse of the Eurozone from the private to the public sector also benefits the savers. As the centre central bank can be expected to always honour its obligations to the commercial banks in its territory, the commercial banks have been able to replace risky foreign assets by safe domestic assets. Thus, at least to the extent that the increase in TARGET claims stems from German banks’ repatriation of money from the periphery into Germany, this increase actually protects the savings of the German public.

Of course, the increase in TARGET claims is not entirely due to the repatriation of German funds. Residents from the euro periphery have also started to move their funds into German banks, most likely to hedge from a possible euro break-up. This results in an increase in Germany's TARGET claims as well. Therefore the question is: To what extent do the additional claims result from the repatriation of German funds?

The consolidated claims of Germany's banks vis-à-vis the rest of the Eurozone give us an idea of what is going on. From August 2008 to January 2012 (more recent data is not yet available), German banks have cut their claims against the rest of the Eurozone by €320bn. During the same period, the net TARGET claims of the Bundesbank have increased by €390bn. Hence, the larger part of the TARGET balances seems to stem from a repatriation of funds.

Thus, the liquidity provided by the ECB which is reflected in the TARGET system has made it possible for German banks to bring their money back home. Without the ECB's intervention, the attempt to shed assets in the periphery would most likely have led to defaults in the banking sector and the wider economy, which would have eroded the value of these assets. German savers – whose money the banks ultimately manage –should therefore applaud the increase in the Bundesbank's TARGET balance.